A risk you can limit is a risk you can take. Drawing the most important lesson from experience. The most effective risk-reduction technique. Why you need to avoid overreacting to problems

"Does the future look as black as they paint it?" This is a question
that you should ask yourself when you read troublesome economic
predictions. On most days, the prevalent opinion in newspapers is a
mixture of distrust and hesitation. Is there a way to make solid
decisions about where to place your savings and minimize financial risk?

A risk you can limit is a risk you can take

In
investments, like in most things in life, it all boils down to using
the right methodology. How can we determine what is true? What facts are
relevant? Which predictions make sense? Can we figure out the future by
applying principles extracted from experience?

"If you intend to
climb a high mountain, always choose the smoothest path," wrote Chinese
philosopher Lao-Tzu in the year 520 BC. In times of economic adversity,
investing becomes the equivalent of climbing the Swiss Alps bare-handed
in the middle of the winter.

After suffering the negative
results of wrong financial decisions, many individuals are reluctant to
place any money in the stock market. Are those fears justified? Making
mistakes is inevitable in any human endeavour. A wise man must be
willing to accept occasional errors and use them as stepping-stones for
building a better future for himself. Why should we not view the stock
market in the same way?

Drawing the most important lesson from experience

The main lesson to be drawn from past
financial mistakes is that, when it comes to investing, methodology is
everything. More careful research can help us make better decisions in
the future. A more disciplined approach can minimize losses. Taking
appropriate measures to reduce risk should prevent us from making the
same faults twice.

The following principles of risk reduction
have endured the best and worst of times. Use them to your advantage to
build a prosperous financial future. From time to time, your decisions
will not be correct, but if you adopt a prudent strategy, you can keep
your losses under control at the same time that you let your profits
grow.

First, choose shares of solid companies, preferably those that
pay regular dividends: Unless you are a professional investor, it is
advisable to avoid speculative stocks of small enterprises whose future
is dependant on one single product or customer. During periods of
economic adversity, well-established companies whose products fulfil
fundamental human needs tend to fare better than small undertakings.

Second, never place more than 5% of your savings on a single investment: Even
if you make a correct decision today, circumstances continuously change.
The easiest way to minimize risk is to spread your savings into many
different assets. The rule of 5% implies that, over time, you should aim
at having at least 20 different types of investments.

If you
save money every month, it will take you less than two years to achieve
this target. Risk reduction is worth the effort of researching 20
different investments. Some of them will turn out to be outstanding
places for your money, while others may deliver negative results. Since
you cannot know in advance, you will be better off by spreading your
money.

The most effective risk-reduction technique

Third, diversify your assets amongst different sectors and
countries: You have no control over what problems will affect specific
industries or countries in the future. Those negative events are, to a
great extent, unpredictable.

Follow the example of professional
investors and spread your savings amongst different types of assets. If
you diversify internationally by placing a good part of your savings in
stable countries around the world, your financial future will be less
affected by problems in any particular territory.

Fourth, understand
that nobody can predict with certainty when markets hit bottom or are
about to crash: You should never act blindly on someone else's advice,
no matter how brilliant their track record is. Everybody makes mistakes
and, as a general rule, it is better to trust facts than opinions.
Listen to wise individuals, but always check things for yourself.

Fifth, save regularly, monthly if possible, in
order to ensure that you will also invest during periods of pessimism.
Psychologically, it is easier to place your money in the stock market
when prices are rising than when the world seems to be falling apart.
Nevertheless, periods of economic misfortune tend to be the best to
purchase assets at a low price.Why you need to avoid overreacting to problems

Making the effort of This last principle is the most
difficult to apply, since it requires enormous self-discipline. If we
overreact to painful past experiences, we will overlook great investment
opportunities. When the stock markets of the world go through a
difficult period, the low prices can offer excellent possibilities for
the future. If you adopt the habit of investing regularly, you will be
able to make profitable decisions when few are willing to take any risk.

The
essential principles of risk reduction will not provide you absolute
protection, but they can help you keep your losses to a minimum.
Whatever your strategy, check facts for yourself and never trust anybody
blindly.

Times of economic adversity are often the best to
rebuild an investment portfolio. As Lao-Tzu observed twenty-six
centuries ago: "Truth is often paradoxical. Don't make the mistake of
believing that you know what you don't know." Making risk reduction a
part of your financial plan can help preserve your peace of mind as much
as your savings.

Text: http://johnvespasian.blogspot.com

Image by moonlightbulb under Creative Commons Attribution License. See the license terms under http://creativecommons.org/licenses/by/3.0/us

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ABOUT THE AUTHOR

JOHN VESPASIAN is the author of eight books about rational living, including "When Everything Fails, Try This" (2009), "Rationality Is the Way to Happiness" (2009), "The Philosophy of Builders: How to Build a Great Future with the Pieces from Your Past" (2010), "The 10 Principles of Rational Living" (2012), "Rational Living, Rational Working: How to Make Winning Moves When Things Are Falling Apart" (2013), "Consistency: The Key to Permanent Stress Relief" (2014), "On Becoming Unbreakable: How Normal People Become Extraordinarily Self-Confident" (2015), and "Thriving in difficult times: Twelve lessons from Ancient Greece to improve your life today" (2016).